Economy gets a boost from falling oil prices

There has been a lot of debate going on recently as to what lower oil prices are telling us and what impact they will have on the domestic economy and the stock market.

Looking at the one-year chart for U.S. oil
USO, +1.15%
below relative to the stock market
SPY, +0.60%
over the last three months oil prices and stock prices have diverged.

This chart seems to fly in the face of the market pundits who claim the recent dip in prices is the result of a weak global economy and therefore a negative indicator for the stock market. Up until a few months ago, oil prices and the S&P 500 were actually moving in tandem. But that relationship has broken down. Oil prices now appear to be driven by supply-and-demand considerations as opposed to a strong dollar and weak global economy.

The good news is that lower oil prices are creating lower gasoline prices at the pump. This puts more discretionary-spending money into the hands of consumers. The latest retail sales figures reflected a nice jump in retail sales in October vs. September. Look at the nice jump in the retail sector recently, as seen through the Market Vectors Retail ETF
RTH, +0.49%

Retail stocks are not the only perceived beneficiaries of lower gasoline prices. Other consumer-related stocks, such as restaurants, are moving up as well. It is obvious to most investors that low oil prices have the potential to boost consumer spending. The U.S. economy is greatly dependent on the U.S. consumer. A healthy consumer translates into healthy economic growth.

There are other positive signs for the economy as well. Weekly jobless-claim numbers remain tame. Job creation remains modest, and GDP is adequate to continue to support current market valuations.

Looking at the level of oil prices today, it is hard to believe than in the late 2007, early 2008 timeframe, a barrel of oil was trading as high as $165. And we all know what happened to the stock market after that ... it plunged.

Now in fairness, there was a lot more going on in 2007-2008 than just soaring oil prices. We had a war going on in Iraq, there was a real-estate bubble, and consumer credit was looser than a toddler's front teeth. But high oil prices were another factor negatively impacting the consumer at the time.

One of the drivers of lower oil prices today is the American shale boom. Over the last few years, the abundant supply of domestic oil has helped keep oil prices low. The U.S. has gone from being 40% energy dependent, to 75% energy independent. That is a pretty big shift.

Now, here comes the downside of lower oil prices. America's oil boom has resulted in a good chunk of job creation over the last few years. The states with the lowest unemployment rates are found in shale zones like North Dakota, Wyoming, Montana, Texas, Oklahoma and Louisiana. Even states like Pennsylvania, Ohio, and Illinois are getting in on the action.

But with oil prices hovering around $75 per barrel some are questioning the economics of shale production. Will oil- and gas-exploration companies cut production and lay off workers? At what price threshold is shale production still economically viable? Based on my personal research, I believe U.S. oil producers will not be impacted greatly until oil declines below $45 per barrel. We are still a long way from those levels.

Oil prices recently broke the three-year support level of $78 per barrel, and it continues to look for support. Not surprisingly, given the sharp recent decline in oil prices, out of the 68 equity sectors I track, energy-related names have been among some of the worst-ranked sectors over the last few weeks.

Bottom 10 sectors last week

Bottom 10 sectors this week

Data from Best Stocks Now app

For now, the offset of lower gasoline prices and the tailwind it creates for the consumer is trumping market concerns about the future of the domestic shale oil boom.

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